Stablecoin 101: Types, Examples, Pros and Cons

Stablecoins are one of the most promising innovations in the cryptocurrency space. They aim to combine the best features of both fiat currencies and cryptocurrencies: stability, speed, transparency, censorship-resistance, and innovation. However, they also come with various trade-offs and challenges that need to be addressed by users, issuers, regulators, and researchers. In this article, we will explore what stablecoins are, how they work, what types of collateral they use, what are some examples of stablecoins, why they are important, and what are their advantages and disadvantages.

What is a stablecoin?

A stablecoin is a type of cryptocurrency that is pegged to a “stable” reserve asset like the U.S. dollar or gold. Stablecoins are designed to reduce volatility relative to unpegged cryptocurrencies like Bitcoin, which can experience large price fluctuations in a short period of time. Stablecoins aim to provide the benefits of cryptocurrencies, such as fast and cheap transactions, transparency, and censorship-resistance, while maintaining a stable value that can be used for payments, remittances, savings, and other applications.

How stablecoins remain stable

Stablecoins achieve price stability by using different mechanisms to link their value to an external reference. There are three main types of stablecoins, based on the type of collateral they use:

• Fiat-backed stablecoins: These are stablecoins that are backed by fiat currencies, such as the U.S. dollar or the euro, which are held by a third-party custodian, such as a bank or a trust company. The issuer of the stablecoin promises to redeem each stablecoin for its equivalent value in fiat currency upon request. The most popular example of this type of stablecoin is Tether (USDT), which claims to be backed by U.S. dollars at a 1:1 ratio.
• Crypto-backed stablecoins: These are stablecoins that are backed by other cryptocurrencies, such as Bitcoin or Ether, which are held in smart contracts on a blockchain. The issuer of the stablecoin uses over-collateralization to ensure that the value of the backing cryptocurrency is always higher than the value of the stablecoin. The most popular example of this type of stablecoin is DAI, which is backed by Ether and other crypto assets at a variable ratio.
• Algorithmic stablecoins: These are stablecoins that are not backed by any collateral, but instead rely on an algorithm that adjusts the supply of the stablecoin according to market demand and price fluctuations. The issuer of the stablecoin uses incentives and penalties to encourage users to buy or sell the stablecoin when it deviates from its target price. The most popular example of this type of stablecoin is TerraUSD (UST), which is backed by a basket of fiat currencies and uses a dual-token system to stabilize its price.

Types of stablecoin collateral

As mentioned above, stablecoins use different types of collateral to maintain their peg to an external reference. The choice of collateral affects the risk and reward profile of the stablecoin, as well as its regulatory and operational challenges. Here are some of the pros and cons of each type of collateral:

• Fiat-backed collateral: This type of collateral offers the highest degree of price stability, as it is directly linked to a widely accepted and regulated currency. However, it also introduces counterparty risk, as users have to trust that the custodian actually holds enough fiat reserves to back the stablecoin. Moreover, it requires compliance with anti-money laundering (AML) and know-your-customer (KYC) regulations, which may limit the accessibility and privacy of the stablecoin.
• Crypto-backed collateral: This type of collateral offers a higher degree of decentralization and transparency, as it is stored on a blockchain and can be verified by anyone. However, it also introduces volatility risk, as the value of the backing cryptocurrency may fluctuate significantly over time. Moreover, it requires over-collateralization to account for price fluctuations, which may reduce the capital efficiency and scalability of the stablecoin.
• Algorithmic collateral: This type of collateral offers the highest degree of innovation and flexibility, as it does not rely on any external asset or intermediary. However, it also introduces complexity risk, as it depends on a sophisticated algorithm that may be subject to bugs, attacks, or market failures. Moreover, it requires strong network effects and user adoption to maintain its peg, which may be challenging in a competitive and uncertain environment.

What are some examples of stablecoins?

There are many stablecoins in the market, each with its own features, advantages, and disadvantages. Here are some of the most popular and widely used stablecoins:

• Tether (USDT): The oldest and largest fiat-backed stablecoin, pegged to the U.S. dollar at a 1:1 ratio. It claims to have full reserves of fiat currency to back up its tokens, but it has been involved in several controversies and lawsuits over its transparency and legitimacy.
• USD Coin (USDC): A fiat-backed stablecoin, pegged to the U.S. dollar at a 1:1 ratio. It is issued by Circle and Coinbase, two regulated and reputable companies in the crypto industry. It claims to have full reserves of fiat currency that are regularly audited and verified by independent third parties.
• Dai (DAI): A crypto-backed stablecoin, pegged to the U.S. dollar at a 1:1 ratio. It is issued by MakerDAO, a decentralized autonomous organization (DAO) that runs on the Ethereum blockchain. It uses various Ethereum-based tokens as collateral that are locked in smart contracts called Collateralized Debt Positions (CDPs).
• TrueUSD (TUSD): A fiat-backed stablecoin, pegged to the U.S. dollar at a 1:1 ratio. It is issued by TrustToken, a platform that tokenizes real-world assets such as currencies, commodities, and real estate. It claims to have full reserves of fiat currency that are held in escrow accounts by licensed trust companies.
• Paxos Standard (PAX): A fiat-backed stablecoin, pegged to the U.S. dollar at a 1:1 ratio. It is issued by Paxos, a regulated financial institution that also offers other services such as crypto exchange, custody, and settlement. It claims to have full reserves of fiat currency that are audited monthly by a top auditing firm¹.

A comprehensive list of popular stablecoins

Here is a table that summarizes some of the popular stablecoins in the market, along with their type of collateral, target price, launch date, market capitalization, and supported blockchains:

Name	Type	Target	Launch	Market Cap	Blockchains
Tether (USDT)	Fiat-backed	1 USD	2014	$68.5 billion	Bitcoin (Omni), Ethereum (ERC-20), Tron (TRC-20), EOS (EOSIO), Algorand (ASA), Solana (SPL), Binance Smart Chain (BEP-20)
USD Coin (USDC)	Fiat-backed	1 USD	2018	$29.4 billion	Ethereum (ERC-20), Algorand (ASA), Stellar (XLM), Solana (SPL), Binance Smart Chain (BEP-20)
DAI	Crypto-backed	1 USD	2017	$6.5 billion	Ethereum (ERC-20)
Binance USD (BUSD)	Fiat-backed	1 USD	2019	$12.8 billion	Ethereum (ERC-20), Binance Smart Chain (BEP-20)
Paxos Standard (PAX)	Fiat-backed	1 USD	2018	$1.3 billion	Ethereum (ERC-20), Binance Smart Chain (BEP-20)
Paxos Gold (PAXG)	Gold-backed	1 Ons	2019	$0.5 billion	Ethereum (ERC-20), Binance Smart Chain (BEP-20), Solana (SPL)
TrueUSD (TUSD)	Fiat-backed	1 USD	2018	$1.2 billion	Ethereum (ERC-20), Binance Smart Chain (BEP-20)
Bilira	Fiat-backed	1 TRY	2019	$0.01 billion	Ethereum (ERC-20)

Why Are Stablecoins So Important?

Stablecoins are important because they offer several advantages over traditional fiat currencies and unpegged cryptocurrencies. Some of these advantages are:

• Stability: Stablecoins provide a stable store of value and unit of account that can be used for everyday transactions without worrying about price fluctuations or exchange rate risks.
• Speed: Stablecoins enable fast and cheap cross-border payments and remittances that can bypass intermediaries and reduce transaction costs and delays.
• Transparency: Stablecoins offer a high level of transparency and auditability that can enhance trust and accountability among users and regulators.
• Censorship-resistance: Stablecoins offer a high degree of censorship-resistance and permissionlessness that can protect users from arbitrary interference or discrimination by governments or corporations.
• Innovation: Stablecoins enable new and exciting possibilities for the development of decentralized applications and platforms that can leverage the benefits of blockchain technology. For example, stablecoins can facilitate smart contracts, peer-to-peer lending, automated market making, and other forms of programmable money that can create more efficient and inclusive financial services.

However, stablecoins also pose significant challenges and risks that need to be addressed by regulators and policymakers.

Advantages and disadvantages of stablecoins

Stablecoins offer several advantages and disadvantages compared to traditional fiat currencies and unpegged cryptocurrencies. Some of these are:

Advantages of stablecoins

• Stability: Stablecoins provide a stable store of value and unit of account that can be used for everyday transactions without worrying about price fluctuations or exchange rate risks.
• Speed: Stablecoins enable fast and cheap cross-border payments and remittances that can bypass intermediaries and reduce transaction costs and delays.
• Transparency: Stablecoins offer a high level of transparency and auditability that can enhance trust and accountability among users and regulators.
• Censorship-resistance: Stablecoins offer a high degree of censorship-resistance and permissionlessness that can protect users from arbitrary interference or discrimination by governments or corporations.
• Innovation: Stablecoins enable new use cases and applications that leverage the potential of blockchain technology, such as decentralized finance (DeFi), smart contracts, tokenization, and programmable money.

Disadvantages of stablecoins

• Counterparty risk: Stablecoins that are backed by fiat or crypto assets introduce counterparty risk, as users have to trust that the issuer or the custodian actually holds enough reserves to back the stablecoin. If the reserves are insufficient, fraudulent, or inaccessible, the stablecoin may lose its peg or become worthless.
• Volatility risk: Stablecoins that are backed by crypto assets introduce volatility risk, as the value of the backing cryptocurrency may fluctuate significantly over time. This may require over-collateralization or liquidation mechanisms to maintain the peg, which may expose users to liquidation risk or governance risk.
• Complexity risk: Stablecoins that are not backed by any assets introduce complexity risk, as they depend on a sophisticated algorithm that may be subject to bugs, attacks, or market failures. This may require strong network effects and user adoption to maintain the peg, which may be challenging in a competitive and uncertain environment.
• Regulatory risk: Stablecoins may face regulatory risk, as they may not comply with existing laws and regulations regarding money transmission, securities, taxation, consumer protection, and anti-money laundering. This may limit the accessibility and privacy of the stablecoin or expose users to legal liabilities or sanctions.²

The bottom line

Stablecoins are a type of cryptocurrency that is pegged to a “stable” reserve asset like the U.S. dollar or gold. They are designed to reduce volatility relative to unpegged cryptocurrencies like Bitcoin, which can experience large price fluctuations in a short period of time. There are three main types of stablecoins: fiat-backed, crypto-backed, and algorithmic. Each type has its own pros and cons in terms of stability, decentralization, transparency, scalability, and regulation. Stablecoins offer several benefits for the crypto market and the global financial system, such as lower-cost, safe, real-time, and more competitive payments. However, they also pose several risks and challenges that need to be carefully considered and addressed by all stakeholders involved.

1. CoinMarketCap. Stablecoins ↩︎
2. Securities and Exchange Commission. President’s Working Group Report on Stablecoins
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